Working Paper
Pitfalls in tests for changes in correlations
Boyer, Brian H.; Gibson, Michael S.; Loretan, Mico (1997)
Correlations are crucial for pricing and hedging derivatives whose payoff depends on more than one asset. Typically, correlations computed separately for ordinary and stressful market conditions differ considerably, a pattern widely termed "correlation breakdown." As a result, risk managers worry that their hedges will be useless when they are most needed, namely during "stressful" market situations. ; We show that such worries may not be justified since "correlation breakdowns" can easily be generated by data whose distribution is stationary and, in particular, whose correlation ...
International Finance Discussion Papers , Paper 597

Working Paper
Evaluating forecasts of correlation using option pricing
Gibson, Michael S.; Boyer, Brian H. (1997)
A forecast of the correlation between two asset prices is required to price or hedge an option whose payoff depends on both asset prices or to measure the risk of a portfolio whose return depends on both asset prices. However, a number of factors make it difficult to evaluate forecasts of correlation. We develop a forecast evaluation methodology based on option pricing, extending a technique that Engle et al. (1993) introduced to evaluate volatility forecasts. A forecast of the variance-covariance matrix of joint asset returns is used to generate a trading strategy for a package of simulated ...
International Finance Discussion Papers , Paper 600